Question

In Transylvania, the basic income tax system is fairly simple. The first 40,000 sylvers (the official currency of Transylvania) earned each year are free of income tax. Any additional income is taxed at a rate of 25%. In addition, every individual pays a social security tax, which is calculated as follows: all income up to 80,000 sylvers is taxed at an additional 20%, but there is no additional social security tax on income above 80,000 sylvers. a. Calculate the marginal tax rates (including income tax and social security tax) for Transylvanians with the following levels of income: 20,001 sylvers, 40,001 sylvers, and 80,001 sylvers. on 20,001 sylvers: 20 % 21 on 40,001 sylvers: % Incorrect 22.5 on 80,001 sylvers: % Incorrect b. The Transylvanian income tax is progressive and the social security tax is regressive c. Which income group's incentives are most adversely affected by the combined income and social security tax systems?

Answer 1

Marginal tax rates in Transylvania depend on income levels, being 20% on 20,001 sylvers (only social security tax), 45% on 40,001 sylvers (income tax and social security tax), and 25% on 80,001 sylvers (only income tax). Transylvania's income tax is progressive, while its social security tax is regressive, affecting middle-income earners the most.

Step-by-step explanation:

Understanding Marginal Tax Rates and Tax Structures

To calculate the marginal tax rates for Transylvanians at different levels of income, we need to consider both the income tax and social security tax. For someone earning 20,001 sylvers, they would only pay social security tax because their income is below the income tax threshold. The social security tax is 20%, so the marginal tax rate is 20%.

For an income of 40,001 sylvers, the marginal tax rate includes the 25% income tax plus the 20% social security tax, making the total marginal tax rate 45%. Finally, for an income of 80,001 sylvers, only the income over 80,000 sylvers is subject to income tax at 25%, as the social security tax does not apply beyond that point, making the marginal tax rate 25%.

The Transylvanian income tax is progressive because tax rates increase as income increases, which contrasts with the social security tax which is regressive since it does not apply to income above 80,000 sylvers, leading to a relatively higher tax burden on lower income earners. This combined tax structure most adversely affects middle-income earners who are taxed at the highest combined rates.